Diagonal call

Article contents



At a glance



Setting up the strategy


  1. Sell one near-term call option on the underlying stock.

  2. Buy one long-term call option on the same underlying stock.

  3. At expiration of the first near-term call option, sell another call option that expires one month after the first near-term call at the same strike price.

Who should run this?

Intermediate to advanced traders.

Margin requirements


Learn more about Questrade’s option margin requirements.

Strategy overview



A diagonal call is an options strategy in which a trader simultaneously buys one long-term call option while selling a near-term call option of the same symbol.

Market outlook


  • Neutral

Strategy benefits


  • Several near-term call options can be sold if the long-term call option expires several months into the future, allowing you to potentially profit multiple times.
  • Maximum loss is limited to the initial debit to enter into the strategy.

Strategy downsides


  • Maximum profit is limited.

Diagonal call example



Scenario


ABC shares are currently trading at $13 in February 2013, and you believe the stock will rise slowly over the next six months. To set up a diagonal call strategy, you do the following:


  • Buy ten September 2013, $13 long-term call options for $3000 ($3.00 option premium x 10 contracts x 100 shares)
  • Sell ten March 2013, $17 near-term call options for $110 ($0.11 option premium x 10 contracts x 100 shares)
To enter into this strategy, you will be initially debited $2890.

Possible results


  1. At expiry in March, ABC shares close at 13.50, meaning the near-term call option expires worthless. This allows you to write another near-term option that expires in April for $110.  The stock continues to gradually rise by 50 cents each month, allowing you to write several near-term call options. In total you wrote five near-month call options, resulting in $550, helping offset the cost of the long call of $3000 and bringing the overall cost to $2450. 

    When the long-term call option expires, ABC shares are now trading at $17.50; as a result, the long-term call finishes in the money and carries a $4.50 intrinsic value per share. Multiply that by a 1000 (10 option contracts x 100 shares per contract), and that leaves your total intrinsic value at $4500.  After subtracting the $3000 required for the long call, plus the $550 premium received from the short term calls sold, your total profit would be $2050.

  2. At the end of the near-term expiry in March, the shares drop in price to $11, meaning the call option expires worthless. The stock continues to plummet over the next several months, and at the end of the long-term call’s expiration, it closes at $8. This means that the long-term call options also expires worthless, and you will lose your entire investment of $2890.

Profit and loss explained



Maximum profit


Maximum profit = option premium received from selling near-term call option - option premium to buy long-term call option + expiration value of long-term call

Maximum loss

Maximum loss = initial debit required to enter into the strategy


Break-even at expiration

Given the two expiration dates, there are too many variables are in play to accurately predict the break-even point.


Sample calculations



  • Stock value at start of strategy: $13
  • To execute the strategy: Sell $17 call option for $110, Buy $13 call option for $3000
  • Result: $2890 net debit at start of strategy
  • Sell $17 call option four more times for $440 after March near-term expiry in April, May, June and July.
  • Result: reduce the net debit to $2450

Result 1

Stock price at expiration Profit and loss calculations 
$13.50 in March (first near-term expiry) $0.11 (option premium)
x
1000 (10 options contracts comprised of 100 shares each)
= $110 credit
$14 in April (second near-term expiry) $0.11 (option premium)
x
1000 (10 options contracts comprised of 100 shares each)
= $110 credit

$14.50 in May (third near-term expiry) $0.11 (option premium)
x
1000 (10 options contracts comprised of 100 shares each)
= $110 credit
$15 in June (fourth near-term expiry)

$0.11 (option premium) x 1000 (10 options contracts comprised of 100 shares each) = $110 credit
$17.50 in September (long-term expiry) $17.50 (stock value)
-$13 (strike price of long-term call option)
=$4.50 (intrinsic value)
x 1000 (10 options contracts comprised of 100 shares each)
-$2450 (cost to enter the trade after applying the near-term call option credits)
= $2050 profit

Result 2


Stock price at expiration Profit and loss calculations 
$11 in March (near-term expiry) $0.11 (option premium) x 1000 (10 options contracts comprised of 100 shares each) = $110 credit
$8 in September (long-term expiry) $3 (option premium) x  1000 (10 options contracts comprised of 100 shares each) = $3000 debit


Maximum loss
= $3000 (debit) - $110 (credit) = $2890 loss


Note
: commission fees are not included in the above calculations.


Payoff diagram






Creating a diagonal call







Standard order details

Order detail

Description

Symbol lookup field

Click  and change the mode to , then enter the symbol you want to buy or sell.

Tip: if you don't know the symbol name, try entering the company name.

The default expiration date, strike price, and strategy appear. 



Modify the expiration date, strike price, and option strategy accordingly. For more information, see Elements of an option quote.

Action The buy or sell action is set for you when you select the strategy type.
Qty

Select a value using the arrows , or enter a value manually.

Note: by default, the quantity will be populated with the value set in your user preferences.
Order type Select the type of order you want to submit. When creating strategy orders, only Limit or Market order types are available. For more information, see Order types.

The limit order type requires you to fill in additional fields. Refer to the table section below for details.
Duration

Select a duration to specify how long the order should remain active. For more information, see Order durations.

Route Select a route or leave the selection at Auto to let the platform determine the best one. Canadian routes will be listed for Canadian symbols and U.S. routes will be listed for U.S symbols.
Sub-route

This field will be filtered according to the route selection. It indicates where you prefer the order to be executed. Leave the selection at Auto to let the platform determine the best route.

Note: sub-route selection is only available for Canadian symbols.
Account

Specify the account you want to use to submit an order. This field will display the account you have set as your default under user preferences, or the account you have selected in any of the linked windows. See Linking and unlinking windows for details.

Order type-specific details
Limit Enter your limit price:

  • To have the price fluctuate according to real-time data, click the lock   and select either Follow ask price  or Follow bid price .
  • To choose a custom price, select Do not follow .
Note: if real-time market data is not available, the limit price will be blank and the float limit icon will be unlocked.




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